A Kinder Gentler Fed - February 4, 2019

Posted By Loveless Wealth Management LLC on 04 February 2019

The Federal Reserve ended its two-day meeting and left interest rates unchanged – no surprise. However, we witnessed a shift in the tone and substance from the central bank. Investors greeted the change with a cheer.

There were two significant adjustments in the post-meeting statement – rates and its balance sheet. The Fed says it can be “patient” on the rate front. In December, the Fed was still talking about the need for “gradual” rate hikes in 2019. Patience implies the Fed won’t be raising rates in the near term, or maybe longer.

Furthermore, when Fed Chairman Jerome Powell was asked at his press conference if the next rate move would be up or down, he said, “It’s going to depend entirely on the (economic) data.” That’s a big shift from December’s projection of one to two rate increases in 2019.

Without providing specific details, the Fed issued a statement that it will be flexible as it shrinks its balance sheet. The balance sheet is a wonky and difficult concept to grasp. A thumbnail sketch – investors had been concerned that December’s autopilot stance might pull too much liquidity out of the financial system.

Just as important, Powell’s tone in his press conference was much different. In December, he stressed U.S. economic strength, which led investors to believe the Fed might raise rates too high and prematurely end the economic expansion. While he said last week that he believes “the economy is in a good place,” he elaborated on a number of risks and took a more dovish stance.

Future rates

A tool provided by the CME Group offers current sentiment on the path of the fed funds rate. Important – sentiment can shift and projections can change but the tool is a useful snapshot.

The graphic below provides us with the current fed funds rate and prior rate hikes (black line). The green line is the current forecast of the path for the fed funds rate through December 2020. Note that it is much lower than the Fed’s own forecast (thin blue line).

Given some of the worries about the economy and stock market action in the fall, market expectations have fallen considerably since late September (red line).

Recent U.S. economic data have generally been encouraging. December’s steep selloff likely did not line up with the economic fundamentals at home, and investors have been reacting favorably.

Any moderating in Q4 may have just been temporary. Or, we may eventually see a moderation in activity later in the year. However, most leading economic indicators are not telegraphing a near-term recession.